WHERE TO INVEST STRATEGICALLY TO ACHIEVE HIGH RETURNS THAT OUTPACE INFLATION?

By Nigel Green

Although the interest rates that sit around 5% in many major economies may currently appear unusually high, especially compared to the sub-1% levels we have seen since 2009, they are on a trajectory toward normalization.

Market expectations suggest that several major central banks will start cutting rates this year, and some like the European Central Bank and Bank of Canada have already done so, yet a return to near-zero interest rates is, we believe, extremely unlikely.

This shift is influenced by long-term demographic changes, such as declining birth rates and increasing longevity in developed economies. These factors contribute to a structural transformation in the economic landscape, making ultra-low interest rates less sustainable in the foreseeable future.

Central banks face a delicate balancing act. They must manage inflationary pressures while nurturing economic growth.

The demographic shift towards an older population is expected to lead to increased age-related spending, such as healthcare and pensions.

Simultaneously, a shrinking working-age population means a declining tax base. This dual pressure will likely place upward pressure on government borrowing costs as expenditures rise and revenue growth slows.

Governments may find themselves in a position where they need to borrow more to meet their obligations, despite higher interest rates making borrowing more expensive.

This scenario creates a challenging fiscal environment where maintaining sustainable public finances becomes increasingly difficult. For investors, this means understanding the long-term implications of fiscal policy and its impact on various asset classes is crucial.

In this context, the role of financial advisers becomes even more critical. Advisers must help clients face head-on this complex landscape by providing insights into how higher interest rates affect different investment types.

The role of cash

While higher interest rates might make holding cash seem attractive, high inflation can erode its value. The real interest rate, adjusted for inflation, is what truly matters. Thus, instead of holding onto cash, it’s time to invest it strategically to achieve returns that outpace inflation.

Cash can provide liquidity and safety, but it should not be a long-term investment strategy in a high-inflation environment. Investors should look for opportunities to deploy cash in assets that offer better potential returns. This might include equities, bonds, real estate, or alternative investments. The goal is to ensure that the purchasing power of their wealth is preserved and ideally grows over time.

Equities and Volatility

Equities, traditionally the cornerstone of many portfolios, are directly impacted by interest rate changes. Historically, higher rates have been associated with robust economic growth, benefiting corporate profits and equity prices. However, in the new normal, heightened volatility is likely.

Higher interest rates increase borrowing costs for companies, potentially squeezing profit margins.

They also make fixed-income investments more attractive, which can lead to a rotation out of equities. Investors should anticipate greater market fluctuations and be prepared for periods of volatility.

Diversifying across sectors and regions becomes essential to managing this risk. Identifying companies with strong balance sheets and sustainable business models will be key to navigating this environment successfully.

Bond Market

Many are also asking whether this environment heralds the return of attractive bond investments. Higher interest rates lead to higher bond yields, making them more appealing to investors. If rates remain high, the yields on existing bonds will continue to be attractive, reversing the trend of recent years where low rates diminished their appeal.

Investors should consider the duration and credit quality of their bond holdings. Longer-duration bonds may suffer from price declines as rates rise, while shorter-duration bonds offer more stability.

High-quality bonds from creditworthy issuers are likely to perform better in a rising rate environment. Also, bonds can provide a counterbalance to equities in a diversified portfolio, offering stability and income.

Investors must adapt to this new era of higher interest rates. Understanding the nuanced impacts on different investment types will be vital.

Financial advisers play a key role in tackling these changes, helping clients make informed decisions to capitalize on opportunities and mitigate risks.

The focus should be on diversification, strategic investment, and maintaining a long-term perspective to thrive in this transforming financial landscape.

(Author is deVere Group CEO and Founder)

Disclaimer: Views, recommendations, and opinions expressed are personal and do not reflect the official position or policy of FinancialExpress.com. Readers are advised to consult qualified financial advisors before making any investment decision. Reproducing this content without permission is prohibited.

2024-07-24T10:50:10Z dg43tfdfdgfd